It's easy to ignore dividends when investing in the stock market, as quarterly payments of, say, $0.31 or $0.57 don't seem like anything to get excited about. That's wrong-headed thinking, though, because dividends are surprisingly effective wealth builders and can even be exciting. Imagine, for example, investing in a growing company and getting 5% of your investment back every year -- while your stock grows in value, too. That's a sweet deal.
Let's review some of the many reasons why dividend investing is hard to beat.
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Dividends tend to be paid by companies that are more stable and less volatile than othersPaying a dividend to shareholders is a commitment that companies don't take lightly, and management will avoid having to reduce or eliminate that payout. Dividends are generally instituted when management is confident that the company will be able to keep paying (and, ideally, increasing) its dividend, due to fairly predictable earnings. Dividend investing can keep you focused on relatively reliable companies.
Dividends, when reinvested, account for much of the growth of the stock marketAccording to Forbes magazine, "... the Dow Jones Industrial Average was at 10,800 on December 31, 2004 and 17,800 on December 31, 2014 for a 10-year price advance of 7,000 points, or 65%, but when dividends are included, the index gained 114% on a total return basis." Data from Morningstar's Ibbotson Associates showthat between 1927 and the end of 2012, reinvested dividend income made up 42% of large-cap stock returns, 36% of mid-cap stock returns and 31% of small-cap stock returns.
Dividends are a powerful way to grow your wealth.
Dividend-paying stocks tend to outperform non-dividend-paying stocksJohn Buckingham of AFAM Capital has cited a study of Russell 3000 companies dating back to 1992 that found dividend payers returned about four percentage points more per year, on average, than non-payers, when weighted equally. Researchers Eugene Fama and Kenneth French, studying data from 1927-2014, found dividend payers outperforming non-payers, averaging 10.4% annually vs. 8.5%.
Dividends grow. It's great to collect, say, a 3% yield on your investment each year on top of stock-price appreciation. But better still is this: dividends from healthy, growing companies tend to get hiked over time often annually. Check out the annual payout from Lowe's, for example:
Growing dividends increase your effective yield, too. For example, imagine that you spend $1,000 on a stock that pays you $30 annually in dividends, for a 3% yield. If it increases that payout by, say, 7% annually, it will be paying you about $59 in a decade. Income of $59 on a $1,000 investment translates to a yield of 5.9%, about twice what you started with. Twenty years after you bought that stock, it might be paying you $163 annually, which reflects an effective yield on your original investment of 16.3%!
Dividends may seem like small change, but they can add up over time and make a big difference to your bottom line.
Dividend income can easily top interest rates offered by banks and CDs -- especially these daysThe national average interest rate for five-year CDs was recently 0.87%, with one-year CDs offering just a third of that, 0.28%. Money market accounts and savings accounts at banks averaged 0.47%. Meanwhile, According to our CAPS stock screener, there were recently 188 stocks with market capitalizations of $10 billion or more and dividend yields of 3% or more. Restrict the list to just those with ratings of four or five stars (out of five), and you still get more than 100. Dividend investing doesn't restrict you very much.
Dividends are not limited to slow-growing companiesYou might not realize it, but plenty of technology-heavy companies with rapid growth potential are paying dividends these days -- and increasing them over time, too. Below are just a few examples of tech companies in the dividend investing universe:
Never invest in a stock solely because it offers a dividend. Some low-quality companies pay dividends, and some dividends -- of good companies and bad -- get reduced or eliminated during tough times. But do consider a dividend a plus when evaluating a company. And know that keeping at least a portion of your portfolio in healthy, growing dividend payers is a smart move, likely to enhance your portfolio's performance. It's not hard to do, either. Even the S&P 500-based SPDR S&P 500 ETFwas recently yielding about 2%.
The article Dividend Investing: It's Hard to Beat originally appeared on Fool.com.
Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter,owns shares of Apple, Intel, Microsoft, and Qualcomm, as does the Motley Fool. Ms. Maranjian also owns shares of Verizon Communications, which is recommended by the Motley Fool. The Motley Fool also recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.